Buying rental at a monthly loss

Haymarket, VA · Member since 2016 · 45 posts · 10 votes

I am considering purchasing a property using 6 year financing at 5.99% interest. In this scenario I would be all in on a property at about $1000 a month. The property would rent for $750, so I would be out of pocket $250 a month. But after the 6 years I would own the property outright and without accounting for rent increases I would be clearing $625 a month. So I would have effectively paid $18k plus maintenance for a property that at year 7 is cashflowing $625+ a month. What are the major drawbacks of this approach?

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Zach White
Rental Property Investor · Collingdale, PA · Member since 2018 · 12 posts · 5 votes
7y
@Michael Osborne
Hi Michael,
That’s an interesting idea. Keep in mind that there are a lot of other expenses associated with properties besides the mortgage. Besides taxes, and insurance, most of the people I take advice from recommend budgeting 5-10% for maintenance, capital expenditures, and property management, even if you’re going to manage yourself. So that would be at least an additional $110 per month you should be setting aside which may leave you more like $400 in the hole for now and leave you cash-flowing only $450 later. There are probably properties around you that would cash flow $400 from the beginning with traditional financing so why not take that route?
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Michael Osborne
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Haymarket, VA · Member since 2016 · 45 posts · 10 votes
7y
Zach, thanks for the reply. I guess my main reason for using a personal loan is that there are no fees associated with this approach. Using a traditional mortgage, if even possible on a $50k property would likely have $2-4k in fees associated with it. I agree your costs are more accurate, so I would plan to have the property paid for much sooner. Thanks for your input.
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Don KonipolBusiness Member
Investor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votes
7y
@Michael Osborne
Your analysis does not take into account the time value of money, I.e., a dollar now is worth more than a dollar tomorrow. The cash flows need to be discounted back to the present value to obtain a true picture.
Basically your question is the same as should I pay my mortgage down fast. The answer is one that is dependent on your goals, aspirations, risk tolerance, income, financial situation, etc.
The scenario you present usually becomes much more interesting when the option involves 0 interest rate or a rate way below market. So, in essence, a 30 yr loan at 6 percent, or a 5 year loan at zero interest.
Bottom line is if the interest rate is the same for both options, then your just trading current dollars for future dollars.
It’s like asking should I collect 100 a month for five years, or should I collect 50 a month for two and a half years and 150 a month for the next two and a half years.
Btw, please be sure to include all expense items in your analysis. Real assets depreciate, while also usually appreciating. They appreciate because land value usually goes up, and the cost of building a similar improvement increases.
They depreciate because things wear out and become outdated. So, if the ac system will need replacing in five years and cost $5000, you should provide for a depreciation expense in your calculation of net income of $1000 per year.
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